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China’s rising interest in Europe

Chinese investors have a powerful attraction to companies in the European Union, and their targets are increasingly high-profile. In recent days, they’ve shown interest in an 18-building compound on Berlin’s Potsdamer Platz and in the Italian tire-maker Pirelli. For some unfathomable reason, Europe considers Chinese investors, even state-owned ones, more benign than, say, Russian ones.

Until 2011, China was mostly a receiver of European investment, but then the debt crisis drove down asset prices. Some governments became desperate to privatize, and venerable corporations got less picky about potential investors. Chinese buyers acquired Volvo in Sweden, a large stake in Peugeot Citroen and fashion house Sonya Rykiel in France, the Piraeus Port in Greece, Pizza Express restaurants and the upscale clothing maker Aquascutum in the U.K. Chinese investment increased exponentially:

BAKER & MCKENZIE / RHODIUM GROUP

Last year — when the Peugeot and Pizza Express deals were made — Chinese merger and acquisition activity in Europe set a new record. Although Chinese investment in the U.S. has also grown, outstripping U.S. flows into China, Europe has proved more welcoming (data in millions of U.S. dollars):

China holds only about 1 percent of the European foreign direct investment stock — not enough to worry about. But this doesn’t include local booms in private Chinese investment, like those in Portuguese or Latvian real estate under those countries “golden visa” programs. Europe is relatively cheap, it’s open, and it’s got things that Chinese companies are after: technology and household names.

The Pirelli deal is about the latter. The bidder, China National Tire & Rubber Company, part of the state-owned giant ChemChina, sells 20 million tires a year, but no one has ever heard of its brands, Rubber Six and Aeolus. It doesn’t have Pirelli’s glorious racing history or its famous calendar. The Italian company seems overvalued — trading at 23 times earnings, compared with 16 for Michelin and 11 for Korea’s Kumho. Yet it has the fifth most valuable tire brand in the world, and the other two European brands in the top five, Michelin and Continental, belong to much bigger companies that make unwieldy targets for acquisition.

For an ambitious buyer with plenty of money and production capacity, Pirelli is the perfect deal. Its market cap is only $7.5 billion (tiny compared with ChemChina’s revenue last year of almost $40 billion), and its name can propel the Chinese tire giant to international prominence. It’s a bit like when the Chinese company Geely bought Volvo — not just for its technology but for its international recognition. Although the market has already overshot ChemChina’s initial offer price, premium and all, it would need to go much higher before Pirelli becomes too expensive for what is essentially an arm of the Chinese government.

Therein lies a problem.

Most Chinese investment in Europe goes into existing, established firms. There are almost no greenfield projects. There’s nothing wrong with private companies — such as Pizza Express buyer Hony Capital, potential Potsdamer Platz investors Fosun International and Ping An Insurance, or Volvo savior Geely — buying into European firms. Cross-border business is common these days. But when old European brands fall into the hands of Chinese state companies, it becomes geopolitics, too: European countries are, in effect, lending part of their heritage to the octopus that is the Chinese government so it can expand its global influence. “For the moment, Chinese investment seems like money falling from the sky, but it could turn … into a Trojan horse introducing Chinese politics and values into the heart of Europe,” Princeton University’s Sophie Meunier wrote in a 2014 paper.

European investors in China are required to set up joint ventures with Chinese partners, and other restrictions apply in specific industries. The EU is trying to negotiate for more openness, but Europe remains at a disadvantage. This isn’t just about reciprocity, however. Openness to investment by Chinese state entities means support for a regime that is not necessarily Europe’s friend and that certainly doesn’t share its values. It’s no better than throwing European markets open to state-owned Russian energy giants such as Rosneft and Gazprom. They would gladly buy up everything they could, if only to strengthen Moscow’s negotiating position with the EU.

These days, European governments are wary of Russian investments, even the private kind. The U.K. is forcing billionaire Mikhail Fridman’s company LetterOne to sell off the North Sea oil production facilities it acquired with the German energy company Dea. It’s not clear what makes state-owned Dongfeng Motor or ChemChina more acceptable.

Europe needs a coherent policy for dealing with foreign direct investment, setting out clear guidelines for what’s permissible, which investors are welcome and which are not. Why not require state-owned companies to put money into greenfield projects only? There is a clear rationale for such deals, including the investment of Chinese nuclear companies in the Hinkley power plant project in the U.K. It would also make sense to require foreign state-owned companies to work with local partners and take only non-controlling stakes, while allowing more freedom for private players. In China, of course, even private companies can serve as instruments of government policy. But at least they are, first and foremost, market agents that deserve equal opportunity to compete.

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